Depreciation- What is Depreciation?
Depreciation in accounting is the allocation of the acquisition cost of a tangible asset over its estimated useful life. In accounting, we talk about depreciation and depreciation of assets. Learn more about the different methods for depreciating an asset.
Difference Between Depreciation and Amortization
Certain assets of the company, fixed assets, lose value over time, due to their wear or obsolescence. Depreciation refers to the allocation of the cost of acquiring the asset over the period during which it will be used by the business in the course of its business operations.
Depreciation therefore refers to the cost of acquiring a goods, whereas Amortization refers to the recognition of the impairment of the intangible assets in the company’s accounts.
Depreciation therefore refers to the value of the asset that must be recorded in the accounts. Depreciation and Amortization are therefore two similar concepts, and they are equivalent in the Anglo-Saxon accounting system.
Depreciation recorded during a year is deducted from taxable profit. The main objective of depreciation is the progressive creation of a monetary amount, which can be used to purchase new assets to replace worn or obsolete assets. In other words, depreciation allows the company to build up capital for the replacement of depreciated capital assets.
What assets can be depreciated or amortized?
It is only possible to depreciate fixed assets, ie assets:
- All tangible capital assets (physical assets)
The company may in particular depreciate : buildings, equipment, furniture, tools, patents, accounting software, etc.
It is only possible to amortized intangible assets, ie assets without physical substance:
- All intangible capital assets (non-physical assets)
The company may in particular amortize: patents, copyright, accounting software, ERP Systems etc.
Attention: the company does not have the right to amortize the goodwill.
It is not possible to depreciate assets consumed by the company quickly, that is to say, fully utilized in the same accounting period as that during which they were acquired.
For example, the company can not depreciate raw materials that are totally consumed during the production cycle.
Base and depreciation period?
The reference amount for calculating depreciation is the cost of acquisition, plus any costs for commissioning and delivery. If the property was obtained free of charge, its depreciation basis is its estimated market value.
The amortization period is the total period during which the asset to be amortized is expected to be used.
Amortization begins on the date the business begins to use the asset.
There are different methods for Depreciating an asset. These methods of depreciation are described in the article”
Straight line method:
This is the easiest and most used method. It is a matter of allocating the cost of the asset over its entire useful life. Each year of use of the asset therefore bears an equal part of the cost.
Reducing balance method:
Same principle as Straight line method of depreciation. The reducing balance method of salvage value results in declining depreciation charges each accounting period. In other words, more depreciation is charged at the beginning of the asset’s lifetime and less is charged towards the end.
Depreciating by Production Units
This method is more complex to use and therefore less widespread. It is not very suitable for small organizations.
It is a matter of accounting for the cost of the asset in proportion to its actual use each year. For example, if an asset is expected to be used very little in one year and much in the following year, a lower cost for the first year and a higher cost for the second year will be recorded.